Factor Rotation Made Easy with this ETF

Factor timing is tricky business and advisors know as much. For those new to the game, they learned the lesson this year as value, which started outperforming late last year, surged in the first five months of 2021.

What followed was a swift decline in 10-year Treasury yields, which supported a rally in growth stocks. In fact, those that penned obituaries for growth stocks earlier this year were hasty in doing so because as of Nov. 24, the S&P 500 Growth Index is beating its value counterpart by 910 basis points on a year-to-date basis.

Translation: Timing when a particular investment factor is going to be in style and when another is going to disappoint is hard, perhaps futile work. History confirms as much. For example, in the 10 years spanning 2011 through 2020, there were six examples of the S&P 500 Quality Index beating the S&P 500, but there were also six instances in which low quality stocks beat the S&P 500. Additionally, there were five years in which the S&P 500 Low Volatility Index beat the standard index, but there were also five instances in which high beta stocks beat the S&P 500.

In other words, advisors face a delicate situation. On a historical basis, embracing factor strategies, single or multi-factor, pays dividends. However, as noted above, figuring out exactly when one factor will top another is practically pointless. Fortunately, there are solutions, including the First Trust Lunt U.S. Factor Rotation ETF (CBOE:FCTR).

FCTR Hidden Factor Gem

The First Trust Lunt U.S. Factor Rotation ETF debuted about three and a half years ago and has $626.23 million in assets under management, but even with those notable credentials, the fund doesn't grab a lot of press. Perhaps that should change.

FCTR follows the Lunt Capital Large Cap Factor Rotation Index, which “is designed to provide exposure to U.S. large-cap equities, rotating among four select factors (momentum, value, volatility and quality) when they come into favor using the proprietary Lunt Factor Allocation Methodology,” according to First Trust.

Currently, FCTR holds 160 stocks exhibiting traits of the following factors: Low volatility, low momentum, low quality and low value. That recipe can help clients avoid some of the conundrums associated with factor investing.

“An intriguing theory to explain the periodic underperformance of certain factors lays blame on their own popularity,” notes First Trust in a recent research piece. “If a factor becomes overly crowded, with too many investors chasing the same stocks and potentially bidding up their prices, expected future returns may be reduced. They become a victim of their own success. A corollary to this notion is that stocks that are least related to crowded factors may be neglected or even have investors betting against them by holding short positions, which could depress current valuations.”

One way of looking at FCTR is that it's a hands-off approach that can help advisors steer clients away from crowded factor trades and perhaps to valuation opportunities or away from richly valued stocks.

An Adaptive Approach

Experienced advisors know there's value in flexibility and that's a theme FCTR capitalizes on.

“One way that investment professionals have sought to smooth out periods of single factor underperformance has been to combine multiple factors,” adds First Trust. “As in the example of value and momentum, excess returns from various factors have often come at different times. While most multi-factor strategies maintain consistent exposure to traditional factors, we believe a more active strategy that adapts to periods of single factor underperformance by incorporating 'opposite side' factors may provide another compelling option for financial professionals.”

Of course, the question is does FCTR deliver the goods in terms of performance? Yes. Thanks to robust active share, the fund beat 96% of rivals in the Morningstar large blend category.

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